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Derek Lowe's commentary on drug discovery and the pharma industry. An editorially independent blog from the publishers of Science Translational Medicine. All content is Derek’s own, and he does not in any way speak for his employer.

Business and Markets

The Dark Side of a Wonderful Investment Story

Biopharma investing has been a constantly erupting geyser of cash these last few years, and wherever there is that amount of money flying around, you will find people ready to help make it disappear. And you’ll find people who are willing to stretch the truth in any way that they find necessary to get in on the action.

The latter is what this article at the Boston Globe details. It’s on Frank Reynolds, founder of InVivo Therapeutics, who are testing a new surgical adjunct to spinal cord injury. Reynolds had a dramatic story of working his way back after such an injury himself, coming out of a terrible car crash (note: don’t spend too long reading that 2010 profile until you read a bit more about Reynolds) that left him nearly paralyzed. He made it to a Sloan Fellowship at MIT, and there met Bob Langer, to whom he confided his hopes to start his own company. He certainly came to the right guy there, since Langer starts companies as quickly as most people order lunch. He took on an idea that Langer’s group was exploring (a sort of sponge that spinal nerves could use as a scaffold after injury) and made the case for starting a whole company around it, and thus InVivo Therapeutics was born.

I won’t detail every twist and turn, but let’s just say that Reynolds left InVivo in the summer of 2013, leaving quite a trail behind him. High-level employees were walking out the door (or threatening to) if they had to continue working with him – Reynolds was almost a caricature of a hard-driving, profane, abusive boss. And he himself was complaining to Langer and everyone who would listen that he wasn’t being properly compensated on just $545k/year, but it appears that he was spending company money on Broadway shows, first-class air travel, and visits to the finest strip joints up and down the East coast (these expenses are currently being litigated). Oh, and he was never in that terrible car crash. He hurt his back unloading a snack-cake delivery truck in 1991. And he was never paralyzed, although he did have complications from back surgery, but that’s not quite as good a story, is it?

Reynolds went on to form another company, with the worryingly odd name of PixarBio, but that’s not going so well, either. He and his associates in that venture appear to have left a substantial debris field of false statements, misrepresentations, and stock manipulation, and in April Reynolds himself was arrested on charges of having defrauded 200 investors. He is presumably spending more time in court than in the strip clubs these days, and probably has no one left to send his table-pounding expletive-filled emails to, other than perhaps his own lawyer, which wouldn’t be a good plan.

And talk of stock manipulation brings me to this separate story from Friday. A group of busy, hard-working biotech investors and executives have been charged by the SEC with defrauding investors in pump-and-dump schemes. These involved three penny-stock biopharmas, and the way the schemes worked is the way that they have always worked, the way that some are working right now this very morning, and the way that stock fraud schemes will work until our sun starts exhausting its hydrogen fuel and cooks the Earth. Here’s how that goes:

Across all three schemes, Honig was the primary strategist, calling upon other Defendants to buy or sell stock, arrange for the issuance of shares, negotiate transactions, or engage in promotional activity. In each scheme, Honig orchestrated his and his associates’ acquisition of a large quantity of the issuer’s stock at steep discounts, either by acquiring a shell and executing a reverse merger or by participating in financings on terms highly unfavorable to the company. In every scheme, Honig, and soiree combination of Stetson, Brauser, O’Rourke, Groussman and Frost, either explicitly or tacitly agreed to buy, hold or sell their shares in coordination with one another, knowing that a pump and dump was in the offing that would allow them all to profit handsomely. Once Honig and his associates had secured substantial ownership of the issuer, they acted as an undisclosed control group, directing the issuer’s management for their benefit, including orchestrating transactions designed to create market interest in the company or to solidify their control.

To profit from their investment, in each scheme, Honig and his associates would arrange and pay for the promotion of the stock, directing their co-defendant Ford, or a similar promoter, to write favorable and materially misleading articles about the company whose stock price they wanted to inflate. In several instances, to magnify the intended boost to volume and price that would follow a promotional article’s release, Honig, Brauser, O’Rourke, Groussman, Melechdavid and ATG engaged in pre-release manipulative trading to generate a misleading picture of market interest in the company’s stock, priming investor interest.

Would you like to read one of those paid-for stock promotions? Well, they’re still up (for now) on the Seeking Alpha site, so have a look. What you’re reading is fiction, complete fraudulent fiction. Its author is the Ford named in the SEC complaint, and he was paid to write this garbage, for the explicit purposes of pumping up the price of “Biozone” so the shares could be unloaded onto the unwary. The article (for example) would have you believe that the company under discussion had a technology ready to go into clinical testing, when the truth was that all R&D efforts had already been shut down, and nothing was ever going to be tested at all. The article states that its author had not been compensated for writing it, although three days before he’d been offered a pile of below-market-price shares to do just that. And on and on.

Does this stuff work? Why yes indeed. Biozone’s trading volume went from zero shares traded, its usual daily performance, to a few thousand shares a day, to a few million within days of the promotion. The stock price nearly doubled, and trading stayed up for the next couple of months. Some of that trading was, of course, all the insiders shoveling their own shares (about 15 million of them) into the bonfire, at a rate (and with a lack of disclosure) that is totally illegal. But the buyers for these had been lined up by the promotional drum-beating. There are other articles about Biozone to be found on Seeking Alpha from that period, by people not named in the SEC indictment, and you can make of that what you will.

Taken together, these stories I’m writing about today (there are plenty more) show what anyone in this business should be aware of already: there’s a lot of bull out there. You will probably have noticed that the remains of Theranos have just been sold off for scrap (no word of any boxes of black turtlenecks in the lot), and that’s just an unusually high-profile example that is different mainly in degree from what happens all the time. There are articles in what should be reputable sources that are completely unreliable – at the high end of the scale because the reporters believed the great story that someone told them, and at the low end because it’s a deliberate fraud from top to bottom. Glowing articles about technologies, companies, and founders should always be subjected to scrutiny, because the incentives to make things look better than they are are very strong. It does not help that there is such a constantly refilling supply of people yearning, sweating and panting, to be parted from their money: the folks in the SEC complaint took in at least $27 million from investors who piled into unknown penny stocks based on some articles by a dude on Seeking Alpha. There will be people ready to take advantage of such customers as long as the carp rise up to the feeding hand. Just try not to be one of the fish.

32 comments on “The Dark Side of a Wonderful Investment Story”

A few weeks ago Megan McArdle argued that insider trading was a victimless crime, because the people on the other side of the trades who lost money probably were going to buy anyway and the insiders selling off actually kept the price low. I wonder if she thinks schemes like this are different in degree or kind- one could argue that people who invest in penny stocks were probably going to lose their money in some high-risk investment, and schemes like this keep the market liquid for investors to fund the occasional real diamond in the rough. (I think that’s a load of crap but I’m trying to imagine how the laissez-faire no-reg crowd thinks we should deal with this situation without the dreaded regulatory state.)

The problem with that is that insider trading screws the stock market – once people believe that they have no fair chance to take advantage of their judgment and skills, they don’t use the stock market, and the efficiency that laissez-faire people are counting on to make government unneeded goes away. People don’t develop the expertise in investing, and people who have money to invest don’t invest (other than people who have connections) which means that lots of useful (and unuseful) businesses don’t get started. It also means that information is even more likely to be asymmetric, and therefore less likely to improve the efficiency of decision making (people don’t know if stock movements are based on better information or stock manipulation). It also generally makes people lose faith in the ability of capitalism to distribute goods on the basis of ability or skill or hard work.

This seems like a good example for “If men were angels, government would be unneccessary.” But they’re not, and are unlikely to become so, and given the opportunity to do harm without penalty, some people will.

That might not be a bad thing, if a lot of inexperienced and/or ill-equipped investors left the stock market because there was a much higher risk of it going bad for them because of fraud. Unfortunately, history suggests that what happens instead is that people pile on to dodgy stuff because of a reportedly reputable person recommending them, and can get burned en masse that way (I’m looking at US Late 19th Century stock investing and markets, with lax to non-existent protections against securities fraud).

And the thing about that is pundits can’t have it both ways. If they believe that the financial markets create public social value by rendering “wisdom of the market” judgments and predictions, then certainly somebody who falsifies the information flow is taking from the public for their own pocket. Somebody who trades on true but non-public information is incrementally making it irrational for anybody but an insider to play in the market, which destroys the posited value of the public market. A stock that allows insider trading logically shouldn’t be publicly listed.

Or if markets don’t create wisdom like that, then a lot of people are financial theorist parasites.

That’s not actually the best argument against prohibiting trading on insider information. The better argument is that it forces information into the open — you can’t trade on inside information without the market ultimately noticing and reacting.

Unlike typical pharma-hype vaporware, Musk has built real, highly-rated electric vehicles and a sustainable factory to do so. He’s also built the world’s most advanced rockets for pennies on the dollar of a comparable government project (by NASA’s own admission).

It’s fine if you don’t like the guy, but he is spending his cash and his sanity for the long-term benefit of humanity. In return, he faces constant media assaults and the staunch opposition of short sellers who stand to lose tens of billions of dollars if he succeeds. Follow the money and see where all those negative articles are coming from.

It’s interesting how his problems began when he actually had to build said EVs, instead of selling not-yet-created products to others.

I do think the comparison of him to penny-ante fraudsters is unfair, as he genuinely seems to want to do things, even if he’s perfectly ready to overpromote his modified Atlas-Vs, and the net result of his EV project was late, expensive, lower-quality EVs than his competitors.

I think his efforts probably fall into the category of the self-promoter who is failing, rather than the outright fraud of many others.

Tesla have been making a goodly number of quite good cars for some time now, so your claim is nonsensical. Likewise the SpaceX launchers really aren’t Atlas Vs. What next? A claim that his tunnels are actually dug by children with plastic beach spades? Fie, sir, away w’ye.

Neither of those are untrue. Tesla has been making cars for some time, and the cars have been good quality. And a SpaceX launcher isn’t an Atlas V.

The cars are still late, expensive, and quite arguably not as good as the competition, though. And he was quite happy to take hefty deposits on cars yet to exist.

As for the Atlas V comparison, you’re probably right to call me on that. It’s similar in capabilities, although it is a bit cheaper. It also isn’t nearly as cheap as it was promised to be. It is arguable as to how exactly it’s cheaper, and if you could call reduced oversight the same as subsidizing, but yeah, it’s a bit unfair. It certainly isn’t the revolutionary design we were promised, though.

That given, there’s no sense in pretending there’s something miraculous about his products, though, and that the only reason someone could complain about their buisiness practices is because they’re paid.

For instance, someone may have paid a deposit, and have finally gotten tired from the years of sliding delivery dates and missed production quotas, and found that a competitors vehicle was just as good, if not better.

I’m honestly not sure which would be worse — failing to get to Mars, or living in a privately-owned Mars colony outside the reach of any government intervention. Imagine working for a guy who can legitimately threaten to shut off your oxygen if you don’t do what he says.

Thanks for that video, it was….entertaining. If I remember correctly, the Italian guy, Santilli, is a well known anti-Semitic lunatic. And I don’t believe he ever taught at Harvard or MIT like it says in the video description. My question is, why is he wearing a Ferrari badge pin on his lapel? To emphasize that he’s Italian?

Beats me (about the Ferrari pin). I used to carry a cheap dollar store wallet with the Lamborghini logo on it, just for entertainment value when I pulled it out to buy stuff at the convenience store. I have never been in any danger of joining the Lamborghini Owners Club, despite an ardent infatuation with that marque’s four-seater, the Espada while in junior high school.

To avoid being one of this guy’s coterie of defendants in various actions alleging defamation,
I’ll refer you to his article in wikipedia.org.

Now that’s chutzpah!! I wonder if deep sequencing of the phenotypes in these stories could explain the sociopathic drive, or are we simply doomed as a species to indefinitely suffer these forms of human expression? Unfortunately it’s everywhere these days, including the highest positions of leadership. Perhaps this is simply the natural selection process for amoral Nature?

p.s. Thankfully, the Barry Honig in this blockchain is not the famous biophysicist at Columbia University.

I’ve always been a Barry Honig (Columbia) fan. If you are a fan of a smaller market sports team, there may be a franchise player who is just f-ing amazing but doesn’t seek/get the spotlight. For me, that was always Barry Honig. So many really cool, insightful contributions.

I honestly wouldn’t be surprised if some of the investors buying that fraudulent penny stock didn’t really care that much about how dodgy it seemed, because it was just part of a balanced portfolio where some of it was being invested in what seemed to be “high risk, high yield” stuff.

It is true that investors will “buy volatility”, especially the semi-/fully- automated traders, and not look so much at the particulars of the underlying. I doubt they will “buy vol” in the pink sheets, first north, neue markt and penny stocks. The liquidity is not there. One will end up trading the waves and trends made by oneself as it were.

“Glowing articles about technologies, companies, and founders should always be subjected to scrutiny”

Chemistry and other science news websites should follow this advice too. We’re at a point where it’s unclear if the author of an article writing about a start-up because of friendship or financial reasons.

And yet, the regular readers of this blog, most of them Derek’s peers in medicinal chemistry and most of the rest of us with professional experience of one sort or another in pharma, do take him seriously – after over ten years in which he’s enlightened and entertained us with commentary firmly rooted in fact.

The problem with tech stocks in general has always been that the “tech” part of the offering is to most investors a black box they must take someone else’s word on. So Seeking Alpha and other online oracles have disproportionate power to influence investment decisions on tech stocks, and the fallout after the inevitable implosion is millions of dollars lost.

(Disclaimer: my last venture in investment was a share in a 401k fund specializing in Pacific equities – which seemed like a bad idea to my buddies at work, given it was the mid-1990, and the American market was effervescing while Japanese stocks were relatively flat. If I’d been able to stay in that fund by 2001, I’d have had the last laugh, though, as what Alan Greenspan called “irrational exuberance” in US tech stocks had its catastrophic effects, and the fund I’d been in remained relatively unscathed.)